Evolutionary Economic Geography: Location of production and the European Union [1 ed.] 9780203893180, 9780415423465, 0415423465

Citation preview

Nearly half a century ago, Walter Isard, the founder of regional science, suggested in his seminal book Location and Space Economy two promising approaches to further development of economic geography: the monopolistic competition approach and the evolutionary approach. As is well known, since the late 1980s, the monopolistic competition approach has been vigorously explored in the New Economic Geography. Then, the exploration of evolutionary approach started in the late 1990s, following the development of evolutionary economics and complexity theory. Although it is still in its infancy, evolutionary approach has been contributing significantly to the enrichment of economic geography, adding new perspectives to the long-term process of structural change in space and in time, In Evolutionary Economic Geography, Miroslav N. Jovanović presents in lucid manner the state of arts in economic geography with a special focus on evolutionary approach. The book covers not only theory but also regional policy and location of production in the context of global economy. I enjoyed reading this wonderfully informative book and learned a lot, and so will you. Masahisa Fujita President of the Research Institute of Economy, Trade and Industry, Tokyo

Evolutionary Economic Geography The purpose of this book is to provide a guided tour through the theoretical foundations of spatial locations of firms and industries in an evolutionary economic framework. It addresses the issues of how a location of business in geographical space is selected and where economic activity may (re)locate in the future. The analysis is in the context of technological progress, innovation, disequilibrium and endemic uncertainty. Jovanović raises pertinent questions such as how willing, motivated and able firms (and governments) are to adapt to constantly evolving new opportunities and challenges over time and to experiment and translate these perceptions into profitable actions. How is their ‘competitive position’ evolving relative to others and changing over time when faced with a stream of constantly arriving new opportunities, innovation, threats and obstacles? Considerations are always supported with a plethora of examples and cases from real life. Jovanović argues that the economy is a complex and constantly adaptive system which is almost always outside equilibrium. Building on this, he suggests that there is an important lacuna in our understanding of evolutionary spatial economics and that there is much space for further multidisciplinary research in this academic and practical area. This book offers an evolutionary and disequilibrium analysis of the subject and makes parallels, where appropriate and possible, among economics, geography, physics, biology and art. It considers key areas in theory, market and production structure, spatial location of domestic and foreign firms, as well as regional policy. In addition, there are references to policy intervention; importance of investment in local social stability, education and training; as well as to uncontrollable variables that are beyond the influence of firms, industries, regions or public authorities. The author offers various evolutionary insights and alternatives to the pure neoclassical equilibrium economic model. This book will be of great interest to students and researchers engaged with disequilibrium economics, evolutionary and complexity economics, economic geography and location of firms and industries in geographical space. Miroslav N. Jovanović is Economic Affairs Officer at the United Nations Economic Commission for Europe, Geneva and Lecturer at the European Institute of the University of Geneva.

Routledge Studies in Global Competition Edited by John Cantwell, Rutgers, the State University of New Jersey, USA and David Mowery, University of California, Berkeley, USA 1 Japanese Firms in Europe Edited by Frédérique Sachwald 2 Technological Innovation, Multinational Corporations and New International Competitiveness The case of intermediate countries Edited by José Molero 3 Global Competition and the Labour Market Nigel Driffield 4 The Source of Capital Goods Innovation The role of user firms in Japan and Korea Kong-Rae Lee 5 Climates of Global Competition Maria Bengtsson 6 Multinational Enterprises and Technological Spillovers Tommaso Perez 7 Governance of International Strategic Alliances Technology and transaction costs Joanne E. Oxley 8 Strategy in Emerging Markets Telecommunications establishments in Europe Anders Pehrsson 9 Going Multinational The Korean experience of direct investment Edited by Frédérique Sachwald 10 Multinational Firms and Impacts on Employment, Trade and Technology New perspectives for a new century Edited by Robert E. Lipsey and Jean-Louis Mucchielli

11 Multinational Firms The global–local dilemma Edited by John H. Dunning and Jean-Louis Mucchielli 12 MIT and the Rise of Entrepreneurial Science Henry Etzkowitz 13 Technological Resources and the Logic of Corporate Diversification Brian Silverman 14 The Economics of Innovation, New Technologies and Structural Change Cristiano Antonelli 15 European Union Direct Investment in China Characteristics, challenges and perspectives Daniel Van Den Bulcke, Haiyan Zhang and Maria do Céu Esteves 16 Biotechnology in Comparative Perspective Edited by Gerhard Fuchs 17 Technological Change and Economic Performance Albert L. Link and Donald S. Siegel 18 Multinational Corporations and European Regional Systems of Innovation John Cantwell and Simona Iammarino 19 Knowledge and Innovation in Regional Industry An entrepreneurial coalition Roel Rutten 20 Local Industrial Clusters Existence, emergence and evolution Thomas Brenner 21 The Emerging Industrial Structure of the Wider Europe Edited by Francis McGowen, Slavo Radosevic and Nick Von Tunzelmann 22 Entrepreneurship A new perspective Thomas Grebel 23 Evaluating Public Research Institutions The US Advanced Technology Program’s Intramural Research Initiative Albert N. Link and John T. Scott

24 Location and Competition Edited by Steven Brakman and Harry Garretsen 25 Entrepreneurship and Dynamics in the Knowledge Economy Edited by Charlie Karlsson, Börje Johansson and Roger R. Stough 26 Evolution and Design of Institutions Edited by Christian Schubert and Georg von Wangenheim 27 The Changing Economic Geography of Globalization Reinventing space Edited by Giovanna Vertova 28 Economics of the Firm Analysis, evolution and history Edited by Michael Dietrich 29 Innovation, Technology and Hypercompetition Hans Gottinger 30 Mergers and Acquisitions in Asia A global perspective Roger Y. W. Tang and Ali M. Metwalli 31 Competitiveness of New Industries Institutional Framework and Learning in Information Technology in Japan, the US and Germany Edited Cornelia Storz and Andreas Moerke 32 Entry and Post-Entry Performance of Newborn Firms Marco Vivarelli 33 Changes in Regional Firm Founding Activities A Theoretical Explanation and Empirical Evidence Dirk Fornahl 34 Risk Appraisal and Venture Capital in High Technology New Ventures Gavin C. Reid and Julia A. Smith 35 Competing for Knowledge Creating, Connecting and Growing Robert Huggins and Hiro Izushi 36 Corporate Governance, Finance and the Technological Advantage of Nations Andrew Tylecote and Francesca Visintin

37 Dynamic Capabilities between Firm Organisation and Local Systems of Production Edited by Riccardo Leoncini and Sandro Montresor 38 Localised Technological Change Towards the economics of complexity Cristiano Antonelli 39 Knowledge Economies Innovation, organization and location Wilfred Dolfsma 40 Governance and Innovation Maria Brouwer 41 Public Policy for Regional Development Edited by Jorge Martinez-Vazquez and François Vaillancourt 42 Evolutionary Economic Geography Location of production and the European Union Miroslav N. Jovanović

Evolutionary Economic Geography Location of production and the European Union

Miroslav N. Jovanović

LONDON AND NEW YORK

First published 2009 by Routledge 2 Park Square, Milton Park, Abingdon, Oxon, OX14 4RN Simultaneously published in the USA and Canada by Routledge 270 Madison Avenue, New York, NY 10016 This edition published in the Taylor & Francis e-Library, 2008. “To purchase your own copy of this or any of Taylor & Francis or Routledge’s collection of thousands of eBooks please go to www.eBookstore.tandf.co.uk.” © 2009 Miroslav Jovanović All rights reserved. No part of this book may be reprinted or reproduced or utilised in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloging in Publication Data Jovanovic, Miroslav N., 1957Evolutionary economic geography : location of production and the European Union / Miroslav Jovanovic. – 1st ed. p. cm. – (Routledge studies in global competition) Includes bibliographical references and index. 1. Economic geography. 2. Production (Economic theory) 3. Industrial location. 4. International economic integration. 5. European Union. I. Title. HF1025.J658 2008 338.6'042094–dc22 2008003404 ISBN 0-203-89318-2 Master e-book ISBN

ISBN: 978-0-415-42346-5 (hbk) ISBN: 978-0-203-89318-0 (Print Edition) (ebk)

С

Ј

Н

, ,

.

Ai miei figli, Jovan e Nikola dedico ogni cosa, tranne questo libro, che non vale tutto l’ amore, la felicità e la speranza che mi danno.

To my sons, Jovan and Nikola, I dedicate everything in the world except this book which is worthless compared with the love, happiness and hope that they provide.

Contents List of illustrations

xiii

Foreword

xvi

Preface

xix

Acknowledgements

xxi

List of abbreviations

xxii

1 Introduction

1

2 Theory

6

3 Regional policy

156

4 Market structure and location of production 195 5 International firms

276

6 Conclusions

366

Annex I

377

Annex II

380

Annex III

385

Bibliography

387

Index

408

Illustrations Figures

1.1

The Gini Index.

5

2.1

Adaptive walk.

52

2.2

Random jumps.

53

2.3

Combining adaptive walk and random jumps.

53

2.4

From positive to negative lock-in regional path-dependent economic development.

60

2.5

Productivity/applications curves for a general-purpose technology.

62

2.6

Productivity/applications curves for a succession of generalp urpose technologies.

63

2.7

Productivity curves for different patterns of two successive general-purpose technologies.

64

2.8

Diffusion of mechanical power in the United States manufacturing firms.

65

2.9

Concave (a), convex (b) and spherical (c) distributions of potential industry locations.

70

2.10 Urban and rural population of the world, 1950–2030.

100

2.11 Ideological distribution of the parties in the US House, 1969–70 122 and 1999–2000. 3.1

Relation between regional manufacturing populations and real

158

wages with varying transport costs. 3.2

Transport costs and equilibria.

158

3.3

Welfare in a trade-diverting customs union.

168

4.1

Effects of innovation on the use of factors.

204

4.2

Trends in R&D intensity by area as a percentage of GDP, 1991–2005.

209

4.3

Characteristics of computers.

230

4.4

Technologies with constant, increasing and decreasing returns to scale.

238

4.5

Cost curves with constant, increasing and decreasing returns to scale

238

5.1

Comparative advantage and location of economic activities.

319

5.2

Transnational corporations and the growth process.

321

Paintings

1 School of Andrea Mantegna, Opportunity and Penitence (ca. 1503– 73 6).

Tables

2.1 Two basic theoretical concepts of how an economy operates

39

2.2 Some unresolved issues associated with path dependence

68

2.3 Clusters costs and benefits

95

4.1 Non-tariff barriers

255

5.1 Similarities and differences between the two globalisation waves 308 5.2 Investors’ motives and determinants for FDI in the target location

314

5.3 Profit in the aircraft industry without intervention

340

5.4 Profit in the aircraft industry with intervention

341

5.5 Potential benefits and real concerns that bring TNCs to the target 352 country/location

Foreword To an increasing extent, economists become interested in geography. Since economists are aware that economic activities tend to concentrate in space, they feel an urge to integrate that fact in their theories and empirical work. Miroslav Jovanović has understood that key message more than anybody else, and contributes a lot to its dissemination. Last year, he already edited three volumes entitled Economic Integration and Spatial Location of Firms and Industries, each of which contained a multitude of key contributions bringing together the disciplines of economics and geography. This new book can be viewed as a continuation along that path. What makes this book interesting is that it brings together various approaches that have criticized the mainstream neo-classical framework in the last decades. It is something that cannot be repeated enough, and therefore, should be embraced accordingly. What these approaches dislike is the way traditional neoclassical equilibrium theory has neglected the role of history, path dependence and increasing returns, among other things. I fully agree that these alternative approaches come indeed much closer to reality. This is especially true for the evolutionary perspective on economic geography, which brings back life into regional economics and economic geography, as Geoff Hodgson would put it. In addition, these approaches tend to take an interdisciplinary perspective, not closing itself off and refusing to dialogue with other disciplines, which has damaged mainstream economics so much in the last decades. It is therefore a great joy to see that many researchers (many of which are heterodox economists) currently embark on this exciting new voyage, and Miroslav Jovanović gives full witness of these new developments and ideas. Implicitly, the book gives a very broad definition of what Evolutionary Economic Geography is. It ranges from New Economic Geography and Endogenous Growth Theory, which are still deeply embedded in the standard neoclassical equilibrium framework, to Complexity Theory and Evolutionary Economics, which are based on a disequilibrium framework, and which employ a range of methodologies going from mathematical modeling to descriptive case studies. The two latter approaches have been extensively discussed in a recent special issue on Evolutionary Economic Geography published in the Journal of Economic Geography in 2007. So, I am not sure I entirely agree that all these approaches can be labeled evolutionary, since not all of them are firmly grounded in evolutionary theory. Having said that, Jovanović makes interesting connections between these different approaches which are thought-provoking, and applies these insights to a range of topics such as the location of multinational enterprises, the formation of agglomerations and clusters, trade patterns between countries and convergence/divergence of regions, among others. What makes the book especially attractive is that many examples are presented to clarify key concepts. The book is full of empirical illustrations, providing explanations for the rise of big companies like Microsoft, IBM, Honda and Lloyd’s, the evolution of cities like New Orleans, Antwerp and Venice, the evolution of the ideological representation of political parties in the US house, how wars affect the location of

industries and how chance events triggered the growth of cities like Cannes, Geneva and Basle, among many others. Now and then, Jovanović makes interesting and quite unexpected connections when he refers to Buridan’s ass, Morton’s fork, the Bar Problem of Arthur, and the Medieval School of Andrea Mantegna. Doing so, his conceptual statements come to life so to speak, and this makes the book very readable. Of course, as always, many questions and unresolved issues remain, and Jovanović is one among the first to admit that. He is right when he states that one of the main scientific challenges is without doubt to cope with complexity issues caused by unpredictability, non-determinacy, contingency, non-linearity and chance events. What also deserves more attention is to demarcate better what Evolutionary Economic Geography really encompasses. To start with, there is a need to separate the New Economic Geography of Krugman from Evolutionary Economic Geography, because they rely on very different theoretical frameworks and assumptions, and they have developed and applied very different concepts of time and space. It is true that they share some general properties, such as path dependence, increasing returns and imperfect competition. Nevertheless as, among others, Ron Martin (Cambridge Journal of Economics, 1999), Ron Boschma and Koen Frenken (Journal of Economic Geography, 2006) have explained at length, the New Economic Geography is still firmly grounded in the maximizing-equilibrium analysis, while the Evolutionary Economic Geography rests on the foundations of bounded rationality-disequilibrium principles. To make matters even more complicated, there is no consensus whatsoever with respect to what evolutionary economics really stands for. In fact, various evolutionary perspectives coexist, and it is crucial to be very specific about that before applying evolutionary insights to regional economics and economic geography. While I fully share the view that Evolutionary Economic Geography has a huge potential to provide a more realistic alternative, most of its promises have yet to be fulfilled. Among many other unresolved issues, we still have to specify what path dependency really means, how it can be measured empirically, and how to test it. Many researchers are also currently embarking on network analysis. An evolutionary perspective provides a promising point of departure to analyze the spatial evolution of networks, but we have yet little understanding of how different types of networks evolve spatially, and why. The same is true with respect to the topic of the evolution of clusters. While there is an extensive literature on clusters, we still know very little of how new clusters come about, and what benefits and costs clusters do provide to local firms along their life cycle. And there is, of course, the issue of policy making. While Evolutionary Economic Geography heavily criticizes neoclassical equilibrium theory’s focus on market failures as a key underpinning of public policy, evolutionary approaches are completely silent on how to pursue welfare policy, monetary policy, et cetera.

In other words, much work still needs to be done. In that context, Jovanović has delivered a very thought-provoking book that provides a major input for further discussion and rethinking in what Evolutionary Economic Geography really means, and what it might offer to academics in disciplines like economics and economic geography, as well to provide decision makers and policy makers more in general. Ron Boschma Professor Regional Economics Utrecht University Utrecht, June 2, 2008

Preface This book provides a new framework for the discussion of an old economic problem: where to locate a firm in space. The new spatial programme is an evolutionary approach to economics and economic geography. Traditional neoclassical equilibrium theory is an elegant and quite convincing academic exercise. Its conclusions are straightforward and offer simple and clear insights regarding the location of firms in space. Its general economic policy recommendation is: always remove all market imperfections. In spite of its complex formulation, the evolutionary approach to spatial economics is much closer to reality. This book gives a theoretical and analytical framework on evolutionary economic geography and may provoke research curiosity. It attempts to contribute to a multidisciplinary exchange of views among economists, geographers and businesspeople within a new evolutionary approach. It also ambitiously includes various contributions to spatial topics that are widely scattered: microeconomics, planning, development, economic geography, regional science, urban economics, location theory, industrial organisation, international trade and integration, foreign direct investment, transport economics, business economics, innovation studies, public finance, price theory, imperfect competition, economics of scale, labour economics, environment and resource economics. The common research denominator in all these fields is the spatial dimension, which is seen as an opportunity, a medium for interactions, as well as a limitation. In the 1980s, the inclusion of imperfect competition and economies of scale rejuvenated spatial economics. It also helped to explain why firms agglomerate and form clusters. Even though the ever-increasing demand for sophisticated quantitative analysis makes results harder to explain and comprehend, while policy advice is more difficult to derive, the introduction of new analytical tools assists spatial economics in finding its proper place in mainstream economics and becoming a hot research topic. The main insight of this book concerns the way one new economic or business system replaces another, and where. Economists need to step out of their ‘old analytical box’ of clean and lean abstract theoretical, mathematical and aspatial models that bring the analysed system into equilibrium. They need to go to real life and the actual operation of the economic system. Neoclassical equilibrium models were based on assumptions that rendered analysis totally unrealistic and useless to some professions. For example, a geographer would argue that societies and real geographical space are so complex that they cannot be expressed simply as mathematical formulae. ‘Pure’ economic models refer to geography only to the extent that it supports the economic analysis of the ‘market clearing logic’ and equilibrium based on very specific and many (unrealistic) assumptions that ease mathematic modelling. This dangerously damages the practical relevance of their conclusions. Economists need to expand their research agenda out of the usual issues that refer to entry, exit and total factor productivity. Certain economists have already broadened the analysis to include issues such as institutions, history, firm heterogeneity in the use of factors, multiple equilibria, evolution, technological and time–space trajectories, spatial location theory, endemic disequilibrium and various

market imperfections. Geographers need to leave their ‘old analytical box’, in which they were interested in economics only to the extent that it assisted them to understand and explain the spatial organisation of societies. Instead of ignoring or bypassing one another, economists and geographers need to try to talk about topics of mutual interest, potential agreement and obvious difference. They may also explore the relevance of complexity theory for the solution of common problems. Regarding problems in real life, underdeveloped countries and regions worry that high value-added economic activity will be located and concentrated in the core developed regions. Currently, prosperous countries and regions worry that at least a certain part of economic activity will move to other regions where wages are lower. All countries and regions worry that a large part of manufacturing production will take place in China. The Chinese worry about their lack of primary resources, and so they locate their investment in places where they find the missing economic links. Thus, all regions are anxious because of the ‘assault’ on what used to be their established geography of production. This attack on the existing local spatial order comes not only from other locations, but also from evolution in technology and innovation, variation in competition, fickle tastes and, in certain areas, an ageing population (changes in demography). The book is organised as follows. Chapter 1 introduces the subject. Chapter 2, the core part of the book, covers the theory behind evolutionary economic geography. It presents the basic concepts, as well as relations between economics and geography, biology, evolution and physics. It surveys theories of locations of firms without consideration of their ownership. Special attention is devoted to complex systems. Spatial units such as clusters, cities and regions are also presented in turn. The chapter also covers the impact of history, expectations and war on the location of firms. Chapter 3 covers regional policy and includes considerations about its objectives, justification and instruments. It also shows the impact of international economic integration on the location of firms and industries. Chapter 4 is devoted to the effect of market structure (competition) on the spatial location of production. It tackles issues such as basic concepts, innovation, specialisation, returns to scale, standards, rules of origin and non-tariff barriers. Ownership, i.e. foreign possession and control of firms, is treated in Chapter 5. This chapter examines international firms, i.e. transnational corporations, and explores the theoretical and practical reasons for foreign direct investment and location of trans-border business activities: what motivates firms to locate abroad? Special attention is also devoted to the evaluation of the effects of globalisation as a great economic and political story of our times. Chapter 6 concludes the book. The presentation in this book has a slight European slant as this is the geographical area most familiar to the author. I believe and hope that Evolutionary Economic Geography will prove useful to scholars, students, researchers, civil servants, business executives and others in widening their knowledge and awareness of the process and interrelation between evolutionary theory and the spatial location of firms and industries in the economy of today and tomorrow. However, if it also attracts the curiosity and attention of those studying economic development, international business and policy-makers, then this is to be welcomed. The bibliography at the end of the book may serve as a departure point for a curious student or researcher into the demanding, expanding, surprising and academically rewarding world of evolutionary economic geography.

Acknowledgements My involvement in spatial economics has its roots in an invitation from Professor Bertram Schefold (Frankfurt) to write and present a paper on international economic integration and spatial location of industries at a graduate summer school, organised by Academia Europea (Bolzano) at the picturesque alpine resort of Bressanone/Brixen, Italy, 31 August to 10 September 1998. While international economic integration was familiar to me, I had only a general knowledge about spatial economics. I accepted the invitation with delight, thinking that it would take me only a short time to draft the paper. I was wrong. It took me very much longer. I was so fascinated by the subject that my intellectual voyage continued through economic geography and through time. Several articles, a book Geography of Production and Economic Integration (London: Routledge, 2001) and a set of three edited volumes of readings entitled Economic Integration and Spatial Location of Firms and Industries (Cheltenham: Edward Elgar, 2007) followed. The present book is the result of the limits of neoclassical equilibrium economic theory to explain the location of firms and industries in real space in a way that is satisfactory to me, at least, and to a growing number of others. Some of the inspiration for this book came from recent works by several economists. I shall cite here just two sources of inspiration: R.G. Lipsey, K. Carlaw and C. Bekar, Economic Transformations: General Purpose Technologies and Long Term Economic Growth (2005) and E. Beinhocker, The Origin of Wealth (2006), to which I refer from time to time. During my work on this book I have benefited from human capital and discussions, as well as delightful and advantageous contacts with many friends and colleagues over long years. There are, however, several to whom I owe special gratitude for a variety of valuable inspiration, encouragement, comments and assistance in the preparation of this book. . Un ringraziamento va a Marina Rossi che mi ha aiutato senza saperlo. They include Lisa Borgatti, Ron Boschma, Richard G. Lipsey, Marinette Payot and Hélène-Divna Tzico Stefanesco, as well as many students at various universities who have listened to my lectures. Jovan and Nikola Jovanović assisted greatly with graphics. The UN library in Geneva, particularly Anthony Donnarumma, provided me with most of the sources. Finally, Chris Hook efficiently handled the production of this book. I am grateful to all of them. The usual disclaimer, however, applies here: it is I who a responsible for all shortcomings and mistakes. In addition, the views expressed are my own and are not necessarily those of the organisation in which I work. Miroslav N. Jovanović Geneva, June 2008

Abbreviations CD

compact disc

CEO

chief executive officer

CFIUS

Committee on Foreign Investment in the United States

DISC

Domestic International Sales Corporation

DVD

digital video disc

EFTA

European Free Trade Association

EMU

economic and monetary union

ERDF

European Regional Development Fund

EU

European Union

FDI

foreign direct investment

FIRA

Foreign Investment Review Agency

GATS

General Agreement on Trade in Services

GATT

General Agreement on Tariffs and Trade

GDP

gross domestic product

GPS

Global Positioning System

IIT

intra-industry trade

IMF

International Monetary Fund

LDC

less developed country

MAI

Multilateral Agreement on Investment

MFN

most-favoured nation

MNE

multinational enterprise

NAFTA

North American Free Trade Agreement

NGO

non-governmental organisation

NTB

non-tariff barrier

OECD

Organisation for Economic Cooperation and Development

PANEURO

Pan-European Cumulation System

PC

personal computer

R&D

research and development

SITC

Standard International Trade Classification

SME

small and medium-sized enterprise

TNC

transnational corporation

TRIM

trade-related investment measure

UN

United Nations

US

United States

VCR

videocassette recorder

VHS

video home system

WTO

World Trade Organisation

1 Introduction Does the eagle mount up at your command, And make its nest on high? (Job 39:37) The question and the pressing problem that has troubled economists and others since the seventeenth century is: why do some areas, regions or countries grow faster than others? The spatial location of economic activity in the future is one of the most important and challenging questions in economics. It is relevant not only for the future location of jobs, their quantity and quality, but also for the creation of profit, tax proceeds, exports, public expenditure, urbanisation and the like. Progress in technology, innovation, changes in demand and certain moves towards a liberal economic policy create new challenges for theorists, policy-makers and business executives. As certain new and a number of old economic activities in manufacturing and services become footloose, highly mobile, fragmentable and internationally connected, one of the most demanding and intricate questions in such a situation is where firms and industries will locate, relocate or stay. Alan Greenspan, the former chairman of the United States (US) Federal Reserve Board, and a prominent policy-maker, said to his colleagues: ‘We really do not know how [the economy] works … The old models just are not working’ (Beinhocker, 2006, p. 22). Or in the words of Beinhocker (2006, p. 6): The economy is a marvel of complexity. Yet no one designed it and no one runs it. There are, of course, CEOs, government officials, international organisations, investors and others who attempt to manage their particular patch of it, but when one steps back and looks at the entirety of the $36.5 trillion global economy, it is clear that no one is really in charge. Hence, the time is ripe for economic theory to try something different from the past and to move on. The objective of the new evolutionary turn in economics is not to downgrade or to demolish the traditional neoclassical equilibrium approach to economics. Its goal is rather to offer a new research agenda that may prove that economics can do much better than before. The problem is that economics is well known as a field that is notoriously slow to accept new ideas and theories, and hence these new ideas may have a bigger impact only in the decades to come. Another difficulty is that economic complexity and evolutionary economic geography is still only a research agenda, and a cohesive theory is still far away in the future. With this in mind, the approach taken in this book is conceptual. The modest objective is to find, clarify and explain key tendencies rather than to provide definite answers.

Evolutionary Economic Geography

2

The spatial location of a firm is an issue only in an imperfect market. In the absence of both economies of scale (no sunk costs) and transport costs (so that location in space makes no difference), the decision as to where to locate production would be easy. With no market imperfections, firms may be divided into units of any size and operate in all locations without any cost disadvantage. What orders and directs an economy and its spatial distribution of activities? How is this done? Where does it go to? Views and arguments about these forces are divisive and different. Some consider that it is the prices system that controls a complex system such as an economy. Others prefer conscious action by economic agents and institutions, while yet others are impressed by innovations of all kinds. As an ending point of economic activity, neoclassical economic theory looks at a general equilibrium. Conversely, an evolutionary model is open to an ever-changing and never-ending dynamic process of transformations in an environment of disequilibrium and strong endemic uncertainty. Economics is passing through one of its most important turning points for a century. The current evolutionary approach to economics offers the possibility of change and an alternative to traditional neoclassical equilibrium theory. This is still a work in progress and an opening for a change in how one thinks about economics. It is an opportunity to change the traditional equilibrium framework of thought. The evolutionary turn in economics is introducing a much wider openness to other disciplines than was the case just a few decades ago. In the 1970s, economists who were thinking aloud outside the framework of neoclassical equilibrium theory and its models were a rare breed. Even today, they are not too numerous. Nonetheless, certain interdisciplinary conversations take place. The purpose of this book is to contribute to this cross-disciplinary discussion about the spatial location of firms and industries within the evolutionary framework. A relentless search for profits in a market economy never lets the economic system and its participants remain in stasis. New goods, services, jobs, firms, industries, clusters and production and management technologies are being created, while old or obsolete ones are modified or vanish. This ceaseless ‘creative destruction’ of and within the system makes the economy evolve over real time. Hence, economic evolution is linked with ever-changing and never-ending innovation and disequilibrium within the economic system. Economic geography was a sleepy backwater for a long time, not because it was uninteresting, but because problems seemed intractable. Evolutionary economic geography studies the origin, changes, direction and speed in the spatial distribution and organisation of production, as well as consumption, in a time perspective. It analyses the dynamic changes in the economic landscape. This field of academic enquiry is multidisciplinary par excellence. It is, however, not (yet) based on a general theory or even a widely accepted system of methodologies and rules. Hence, it offers wide, uncertain but potentially rewarding possibilities for deeper research and analysis. Economic geography aspires to analyse and describe economic changes and tendencies and their reasons in physical space. It considers the widest array of geographical locations. All societies and market-oriented firms must decide what, for whom, how and where to produce. Our concern in this book is linked with the spatial ‘where’ part of this decision-making process. In this complex situation, the crucial

Introduction

3

questions for research, analysis, business decisions and economic policy include the following: • Where will economic activity locate (and stay) in the future? • What are the dynamics of the development and growth processes? • Are these processes deterministic or unpredictable? Are they leading towards (a higherlevel) equilibrium or is it a perpetual, uncertain and unpredictable process? • Why is production (and consumption) concentrated in urban areas or regions? Why do urban and other areas differ in size? • What are the reasons for the uneven spatial distribution of economic activity and prosperity?1 • Is it smart to keep the existing industries where they are? What is the opportunity cost of doing this? • Does market expansion through international economic integration encourage agglomeration, clustering, spatial concentration of industries, adjoint locations of linked production and ‘thick’ market effects? Or, alternatively, does agglomeration encourage economic integration? • Does integration cause convergence or divergence in the geography of production, income levels and/or growth rates in the participating countries? • How do these forces interact? Where do they lead the economy? • What is the role and effect of public policy (intervention)? • What are the current and future properties of economic adjustment (spatial and industrywide reallocation of resources) to the changing situation? • Where will ‘hot’ and ‘cold’ spots for the location of business be situated? • Who will benefit from these developments? These are all important and difficult issues to analyse and resolve. Evolution is a process of unfolding, self-transformation and self-organisation; it follows oscillations and the appearance of events in orderly succession over a long period of time. This process is irrevocable, and the historical card, song or CD is played only once. Complexity and evolutionary economics deals with the actions, reactions, competition among various expectations, strategies and whims of economic actors. It is also concerned with the phenomenon of how these fit into the aggregate out-ofequilibrium and everchanging picture. With this in mind, it is clear that relations between economics and evolutionary biology were known and recognised a long time ago. However, these interactions were put aside by many researchers in the field of economics. Evolutionary economic geography deals with the evolution of economic units (such as firms, industries, clusters, cities, regions, states and integration arrangements among states) in geographical space. It considers not only their location and relocation in physical space, but also their creation, operation in the market, growth and demise over time. For instance, where a firm moves in business and in space depends on the starting position: where was its location and how was it created? Thus, history and expectations may assist in the explanation and comprehension of the (likely or wanted) future. Evolutionary economic geography differs from the traditional model in several important dimensions. The new evolutionary model makes the case that production specialisation in a given locality is based not only on certain local comparative

Evolutionary Economic Geography

4

advantages, but also on a self-reinforcing lock-in effect, path dependence, accumulated knowledge, agglomeration, clustering and linkages (indivisible production). In addition, while the traditional models reason that a reduction in trade costs among locations may favour local specialisation, the new evolutionary economic geography claims that the effect on local specialisation is ambiguous. The final outcome is industryspecific and depends on the functional intra-industry production linkages, market structure, consumer preferences (homogeneity of tastes), factor market (availability and mobility of factors and flexibility in prices) and expectations. Evolutionary and complexity economics is compounded with constant shocks, uncertainties and dynamics, as well as evolving changes on an immense scale. Persisting disequilibria are a big game in town. One may feel uncomfortable with this situation, but the evidence against it is not convincingly presented. Evolutionary concepts consider economic changes in conditions of bounded rationality. It is a constant search for optimal solutions in conditions of scarcity, competition and endemic uncertainty. The process deals with creation, differentiation, selection (including mistakes), adaptation, innovation, retention, amplification, replication and constant search for creative– destructive optimal solutions in a pool of many and various possibilities. Compared with neoclassical equilibrium theory, complexity and evolutionary theory of economic behaviour is another general and conceptual look at how the world works. This evolutionary theory is concerned with: • uncertainty, against which one cannot get insurance; • (micro-)analysis of endogenous technological change, innovation and their spillovers; and • non-maximising behaviour of profit-oriented firms. This introduction sheds light on the continuing importance of research efforts, public debate and the search for appropriate policy to face the challenges of spatial distribution of economic activity in the light of evolutionary changes. Let us now see what theory says about evolutionary economic geography.

Notes 1 The Gini index (Figure 1.1) compares the actual distribution of activities with an even (standard) distribution. It measures the degree of similarity or inequality in a distribution (for example, spatial location of firms or income). This index is a ratio between of area between the Lorenz curve of distribution and the curve of the uniform distribution. Zero measures perfect equality, while perfect inequality corresponds to 1 (one region has all the firms or one person has all the income). Applied to the spatial concentration of firms, this index does not take into account the size of firms. Some industries may be organised in a few large firms (chemicals, finance, car assembly), while others may be composed of a number of small firms (food, textiles).

Introduction

5

Figure 1.1 The Gini index

2 Theory Anyone who hears and obeys these teachings of mine is like a wise person who built a house on solid rock. Rain poured down, rivers flooded, and winds beat against that house. But it did not fall, because it was built on solid rock. (Matthew 7:24–25)

1 Introduction Where economic activity will locate in the future is one of the most important and challenging questions in economics. Progress in technology, changes in demand and certain moves towards a liberal economic policy create new challenges for theorists, policy-makers and business executives. As certain new and a number of old economic activities became ‘footloose’, highly mobile, fragmentable and internationally connected, one of the most demanding and intricate questions in such a situation is where firms and industries will locate, relocate or stay. The purpose of this chapter is to provide an overview of the theoretical foundations of the field of spatial economics, especially its evolutionary side. It considers factors and conditions that influence decisions on where to locate a business or an industry in an evolutionary space. A research agenda (Section 2) is followed by considerations about relations between economics and geography in Section 3. Basic concepts in biology, economics and evolution are found in Section 4. Theories of location (Section 5) are presented without concern about the ownership and control of firms; foreign ownership issues are covered in Chapter 5. Complex systems and evolutionary economics are the focus of Section 6. Section 7 discusses various locational possibilities in space. Select spatial units, i.e. clusters, cities and regions, are analysed in Section 8. The impact of history and expectations on the location of firms and industries is described in Section 9. Section 10 deals with the effect of war on the locational issues, while Section 11 concludes the chapter.

2 Issues Spatial economics or the geography of production and consumption studies the spatial relation among economic units. This academic field has been separately and often indirectly analysed as a sub-branch of a number of subjects within economics and geography. It has, however, been treated with different intensity and depth within those research disciplines. Contributions are scattered widely across fields which include: microeconomics, planning, development, economic geography, regional science, urban

Theory

7

economics, location theory, industrial organisation, international trade,1 foreign direct investment (FDI), transport economics, business economics, innovation studies, public finance, price theory, imperfect competition, labour economics, environment and resource economics. The (small) common research denominator in all these areas of academic enquiry was the spatial dimension in terms of geometrical distance in metres. This was usually seen as an opportunity (power to be exploited), a medium for interactions and a limitation. Space and geographical distance may be considered in terms of trade costs, i.e. all costs linked with getting the final good to the consumer (tariffs, quotas, non-tariff barriers [NTBs], transport, storage, distribution, information, contract enforcement, insurance, exchange and banking), differences in language, culture, political system and risk premia. It may also be seen in terms of relations (networks) among economic agents. In a cluster or an industrial district, for instance, firms, labour and institutions interact in formal and informal ways. They influence one another and they learn from each other. As a multidisciplinary research field, new2 spatial economics has tried to integrate these previously separate research areas.3 This is in line with the new trend in science which includes merging various methods in research.

3 Geography and economics Dialogue between geographers and economists was minimal for a long time. Neoclassical equilibrium economists lived in the world of free-market forces and outcomes based on the rational choices of economic agents that brought equilibrium outcomes in space (these outcomes are exemplified and defined by an absence of further change). Limited intervention was accepted in the cases with market failure. Geographers, on the contrary, looked at the (capitalist) market economy as something that is in a perpetual state of conflict and disequilibrium, rather than harmony. The nature and composition of the economic process and decisions by players are shaped and directed by the social, cultural, administrative and political context. Hence, geographers were interested in studying and understanding the complexity of people’s livelihoods. A cultural turn with reduced economic content in part of (economic) geography became apparent after the ‘quantitative revolution’ in economics during the 1960s.4 Economists started increasingly to write professional articles for each other. To some observers, these highlight technical rigour and virtuosity, rather than relevance for life.5 Within this general set-up, there were sharp criticisms between economists and geographers. Geographers viewed economics as too narrow and naive in its analysis, as market forces were settling everything on their own for everyone’s benefit. Conversely, many neoclassical equilibrium economists disregarded geographers as the ones with a lack of quantitative rigour in analysis and criticism, as well as those who were too negative about the principal neoclassical economic equilibrium workhorse: liberal markets that put all things right (almost) on their own at the end of the day. Martin (1999) critically surveyed the new ‘geographical turn’ in economics. He argued that the ‘new turn’ is not more that a reworking of the traditional location theory and regio